reading-time-options

Two-Minute Take: The Federal Deficit

With the federal deficit expected to be the largest in history within 16 years, economic growth expert Cullum Clark explains the national deficit and its impact.

Explain the federal deficit for us. How does it impact the economy?

The federal government has run a budget deficit in all but three of the last 50 years, meaning that it consistently spends more than it takes in from taxes. The U.S. Treasury finances its deficits by borrowing money from the public through bond issuance. The sum of all the outstanding Treasury bonds is the national debt. Over the past 40 years, the federal budget deficit has generally amounted to two or three percent of gross domestic product (GDP); in fiscal year 2018, it was 3.9 percent. As of the end of fiscal year 2018, the national debt stood at $15.6 trillion, or 78 percent of GDP, fast approaching a level we have not seen since World War II.

A small deficit is not a problem for the economy, as the U.S. government is the world’s most creditworthy borrower and can easily fund small deficits through bond issuance. Today, however, a combination of recent tax cuts, spending increases, and the accelerating retirement of the Baby Boomer generation is pushing the federal deficit to uncomfortably high levels. The government’s spending and tax revenues this year will amount to 21 percent and 17 percent of our economy, respectively, implying a deficit at four percent of GDP. This is a larger share than the U.S. has ever experienced when the economy is booming.

Looking ahead, government accountants project that the government’s deficits will exceed five percent of GDP within three years, and as much as nine percent within a decade. The national debt will grow explosively absent a policy shift, from 78 percent of GDP now to over 105 percent by 2028 and 150 percent by 2048.

This path is not sustainable. Growing federal spending on the big three entitlement programs – Social Security, Medicare, and Medicaid – will increasingly crowd out all other national priorities. Soaring bond issuance will bid up interest rates in the economy as a whole, choking off private sector capital investment and research. Or, in the event that the Federal Reserve lets itself be bullied into acquiescing, soaring bond issuance could result in higher inflation, which reduces the value of savings and destabilizes the economy. The debt burden will become a millstone weighing down America’s economic growth.

What does it mean that we will soon surpass the deficits of the immediate post-World War II years?

The U.S. government ran huge deficits to fund the war effort from 1941 to 1945, in the context of a global war against existential threat to our nation. But the deficit quickly fell back below 10 percent of GDP after the war’s conclusion. In the immediate postwar years, we continued to pay for an enormous military presence around the world for several years. It is remarkable that, within a decade, the federal government will incur deficits even larger as a share of the economy than it incurred in those years, even as the national defense has become a far smaller part of government spending.

Author

J.H. Cullum Clark is Director, Bush Institute-SMU Economic Growth Initiative and an Adjunct Professor of Economics at SMU. Within the Economic Growth Initiative, he leads the Bush Institute’s work on domestic economic policy and economic growth. Before joining the Bush Institute and SMU, Clark worked in the investment industry for 25 years. He served as an equity analyst and portfolio manager at Brown Brothers Harriman & Co. (1993-96), as a portfolio manager at Warburg Pincus Asset Management (1996-2000), as President and Chief Investment Officer of Cimarron Global Investors, a Dallas-based hedge fund firm (2000-02), and as President of Prothro Clark Company, a Dallas family investment office (2002-18). Prior to entering the investment industry, he served for one year on the staff of the U.S. Senate Select Committee on Intelligence.

Clark fulfilled a lifelong goal by earning his Ph.D. in Economics at SMU in May 2017, and subsequently joined the faculty of SMU’s Department of Economics. His research has focused on monetary policy, fiscal policy, financial markets, economic geography, urban economics, modern economic history, and economic growth.

Clark's volunteer leadership activities include serving on the boards of Uplift Education, the Eugene McDermott Foundation, the Yale University Art Gallery, and the Foundation for the Arts, as well as on the investment committee of SMU. He earned a B.A. in History from Yale University in 1989 and an A.M. in Political Science from Harvard University in 1993, in addition to his Ph.D. in 2017. After graduating from Yale he lived for one year in Japan. Clark and his wife Nita have three daughters: Lili, Annabel, and Charlotte.